In an earlier post, we discussed some of the major issues involved when tax professionals counsel partnerships in 1031 exchanges.
As we saw, this can be a very delicate matter. Partnerships must handle their exchanges properly or else face severe negative consequences, including the dissolution of the exchange. Another area where CPAs, tax attorneys and other tax professionals can be of great service by providing correct counsel is the related party exchange. This situation must be handled with caution and precision.
In this article, we will go over three issues CPAs can provide guidance on. The first is simply the identification of a related party within the meaning of the code. Accountants need to be aware of what constitutes “relatedness” so they can identify potential related party exchanges. The second issue deals with the associated holding or ownership requirements, and the third involves the provision within the code pertaining to the underlying structure of the transaction.
Issue 1: The Identification of Relatedness
When a client inquires about an upcoming exchange, you should ask them about the possible relatedness of any involved party. A transaction will be classified as a “related party exchange” if either the buyer or seller has relatedness to the taxpayer. According to document 1031(f)(3), which provides a borrowed definition from Sections 267(b) and 707(b)(1) of the Tax Code, relatedness depends on whether the parties involved are individual or corporate persons.
In many ways, the applicable definition is more or less intuitive, but in others, it is not. For instance, family members are related parties, but not every degree of relatedness is encompassed by these sections. Cousins are excluded, as are uncles and aunts. Persons involved with trusts, i.e. grantors, fiduciaries and beneficiaries, also may be classified as related. It won’t be easy, but tax professionals should take the time to master their understanding of the term.